Financing solutions

Mezzanine finance

Essentia is one of the few companies in the
Baltics offering advisory services for finding mezzanine capital throughout the Central and Eastern Europe.

MEZZANINE: ESSENCE AND USAGE

Mezzanine means literally in the middle, thus mezzanine financing
refers to a hybrid capital ayer on the company's balance sheet in
between debt and equity.

Mezzanine capital is ranked behind senior debt in terms of
security and cash payments, both interest and principal. In return,
it will demand a higher return than senior debt. But as a
quasi-equity instrument it usually ranks above the shareholders. As
an instrument, mezzanine can be regarded as debt or equity therefore
mezzanine can be also considered rather as cheap equty rahter than
an expensive loan.

The drawing above states that no matter how the instrument is
technically structured it can be still regarded as a mezzanine if it
corresponds to certain characteristics. The latter means that the
loan must be typically structured to offer the mezzanine lender some
form of equity upside, providing the chance to share in any uplift
in the company’s equity value through warrants or options.

For defining the usage of mezzanine it is crucial to stress that
it is typically not used for covering day-to-day operations (working
capital) because it should be rather used during transitional
periods in the life of a company when extra financing is required.
Also, mezzanine is a product not meant for start-ups or early stage
companies.

Where is mezzanine used then?

To achieve a clear picture we have pointed out the most typical
list of financing needs that can be addressed by offering mezzanine:

acquisitions and management buyouts,

business expansion,

recapitalizations,

new product launches and diversification,

long-term working capital to support growth,

equipment and owner-occupied real estate purchases,
dividends.

Mezzanine investors look for companies with the following
characteristics:

Proven and predictable cash-flow

Well-established operations

Clear competitive advantage(s)

Reasonable and sustainable market position

Strong and focused management team

Predictable exit route

Alignment of interest

Prudent and transparent accounting and budgeting

MEZZANINE RATIONALE

Mezzanine fills the gap between debt and
equity in many transactions such as buyouts. However it has also
proven to be effective in financing other activities such as
refinancing and expansion.

Using mezzanine for recapitalisation and
ownership restructuring deals enables companies to streamline their
existing debt structure thus reducing the proportion of short-term
amortising debt. Mezzanine can also be used to buy-out minority
shareholders or in some cases it may be even used by existing
shareholders to achieve liquidity without ceding control. While
equity investment may be attractive to some businesses because it
does not require interest payments or principal amortization it may
also involve higher long-term costs, the inability to exit, and
management control issues. Therefore, mezzanine financing may offer
the advantages of a lower cost, no management control, and a
predefined exit arrangement

It is obvious that mezzanine providers are
not competitors to banks or equity sponsors but rather co-operate
and support them in expansion, restructuring, recapitalisation and
buy-out deals.

Mezzaninine

Mezzanine is a hybrid financing instrument that shares the
characteristics of both debt and equity.